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Seed Enterprise Investment Scheme

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Review: Elderstreet VCT

Archived article

Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.

Launched in 1998, Elderstreet VCT is
a generalist VCT that provides development and growth capital and largely invests
in unquoted companies but also offers investors some exposure to AIM. This is a £20 million top up offer of the existing share class, which is in now in its over allotment facility. Prospective investors will be buying into an
established and diverse portfolio.

In November 2016 Elderstreet struck a
deal with Draper Esprit to sell them a 30.77% stake in the business. Draper has
the option to acquire the whole of Elderstreet Investments in the future. Draper
Esprit is a leading and experienced venture capital investment firm with a
focus on high-growth technology businesses. Since inception, Draper has invested
more than £800 million into more than 200 tech companies. They also have a
combined exited value of over £5 billion.

Highlights

Well-established VCT

Merger with Draper Esprit adds weight and expertise

Good history of dividends to date (past performance is
not a guide to the future)

Dividend target return of 3p to 4p per share (not
guaranteed)

Well-diversified portfolio

£6,000 minimum investment

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The manager

Elderstreet Investment Limited is a venture capital
company founded by Michael Jackson. From 1987 to 2006 Mr Jackson was the
chairman of FTSE 100 company Sage Group and has directorships of several
portfolio companies. The four key players that make up the investment
management team have in aggregate more than 50 years of venture capital
experience.

The deal with Draper Esprit should boost
the capabilities and resources of the investment team. Draper Esprit’s focus is
well suited to VCT and EIS investing. They are well-known for their respected growth
EIS fund.

The Draper Venture Network – of which
Draper Esprit forms a part – is comprised of ten independent growth and venture
funds managing hundreds of companies in multiple territories. Draper Esprit
believes its position within the network gives it a competitive edge when it
comes to deal flow and due diligence. With headquarters in Silicon Valley, the
Draper Venture Network is well placed to source funding from the US and open up
new markets for portfolio companies.

At the same time as the deal was
announced, a co-investment arrangement was also agreed. Draper Esprit and
Elderstreet will share deals and investment resources.

In the long run, the combined investment
expertise should prove a fillip to the VCT. However, it may take some time for
the partnership to bed in. In due course investors can expect the existing
portfolio to be turned over in its entirety and replace by new opportunities
selected by Draper Esprit. Realising the portfolio may not be straightforward.
On average, the unquoted companies within the portfolio have been held for
eleven years.

Strategy and target
return

Elderstreet’s investment policy is not set to change
significantly as a result of the Draper Esprit deal. The intention remains to
build a diversified portfolio of companies in need of growth capital.

The manager believes the merger will
allow the Elderstreet VCT to access larger deals in companies with higher
revenues and higher growth potential.

Investments are made across a broad range of sectors:
from fields as far flung as property to logistics and from gas utilities to the
manufacture of sports ammunition. Indeed their largest holding is Lyalvale Express,
a producer of shotgun cartridges. Recent investments have included companies in
mobile ecommerce and on-demand delivery.

The average deal size is £1 million. 30% of the portfolio
will be allocated to early stage companies – usually with revenues of between
£0.5 and £1.5m – which carry higher growth potential. The remaining 70% will be
placed into later stage investments with revenues over £1.5m.

VCT rule changes will mean that more investments will be
made into companies that are not yet profitable. This may see a shift in the portfolio
makeup over time.

Whilst the Elderstreet team is sector agnostic, they will
generally look for investments with the following characteristics:

Businesses with proven sales and the ability to
grow, seeking growth capital

Businesses with strong, balanced and
well-motivated management teams

Investments which, where appropriate, include
loan notes and preference shares to enhance the security of the portfolio and
to provide income

Investments where Draper Esprit plc and
Elderstreet Investments can typically act as lead investor and have an active
involvement in the business through a board position.

Elderstreet VCT has historically targeted an annual
dividend of 4-5p per ordinary share. This target will reduce to between 3-4p
per annum.

It’s worth noting Elderstreet VCT has relatively large
reserves. Future dividends should be supported by this capital even if no
disposals are made.

Example holdings of Elderstreet VCT

These are the
five largest investments by asset value in the portfolio as of 31 December
2016:

Lyalvale Express Ltd

Elderstreet VCT
first invested in Lyalvale Express in 1998. Currently, the VCT owns 44.2% of
the company, which manufactures over 30 different varieties of shotgun
ammunition. It was Lyalvale cartridges that Richard Faulds shot to win Olympic
Gold in Sydney.

Fords Packaging Topco Ltd

Based in Bedford,
the business manufactures foil capping and sealing equipment. Elderstreet first
invested in 2009. The company has a presence in North America and has supported
the world’s food and beverage industry since the 1920s. It benefits from global
partnerships with packaging manufacturers.

Access Intelligence plc

Access
Intelligence offers software as a service (SaaS) for PR and communications. As
at the end of November 2015 the business was turning over £8.1m and had a
market capitalisation of £11.81m

It counts the
BBC, Penguin Random House and Debenhams amongst its clients.

Fulcrum is the
only independent utilities infrastructure provider covering the entirety of Great
Britain. It has an established customer base of over 1,200 clients and repeat
revenues account for more than 60% of its business

AngloINFO Limited

AngloINFO is a
network of websites for British expatriates. The idea is to provide local
business directory, classified advertising and information services in the
English language. Elderstreet first invested in 2006.

Exit strategy

Given the diverse nature of the portfolio – and the
varying maturities of the business – there is no ‘one size fits all’ exit
strategy.

The two most recent exits were from SMART Education
limited and Wessex Advanced Switching Products (WASP), both significant ones.

Risks

The common risks
associated with smaller companies investing exist within this VCT offer. VCT
investments are illiquid and capital is at risk. Investors should only invest
money they can afford to lose. The value of tax relief will depend on the
circumstances of the individual investor and tax rules could change in future.

There is a risk
the Draper Esprit and Elderstreet merger is an unhappy one but the signs are
positive thus far.

Fees

There is an initial charge of 5.5%, before any Wealth
Club discount. Total annual running costs are capped at 3.5% of the
company’s net assets. The performance fee is 20% of distributions more than
3.5p per share per annum. If the distribution is not met in any given year
there is a catch-up position for the following year. Simply put: where the
distribution is less than 3.5p the shortfall must be made up before a
performance fee is levied.

The manager may charge an arrangement fee to each
investee company and this is restricted to 3% of the gross amount invested in
the business. Fees may also be due for monitoring services and non-executive
director expenses.

There is a buy back facility in place: this is typically
done at a 7.5% discount to Net Asset Value.

Summary

The majority of
Elderstreet’s existing VCT investors will probably be very content. Dividends
have been consistent and the management team have stuck to their guns. The
portfolio is well diversified and gives investors access to multiple sectors.

We welcome the
additional influence of Draper Esprit, although the impact of the merger may
not be immediate.

Wealth Club aims to make it easier for
experienced investors to find information on – and apply for
– tax-efficient investments. You should base your investment decision on the
provider's documents and ensure you have read and fully understand them before
investing. This review is a marketing communication. It is not advice or a
personal or research recommendation to buy the investment mentioned. It does
not satisfy legal requirements promoting investment research independence and
is thus not subject to prohibitions on dealing ahead of its dissemination.

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